One of the program managers in the Microsoft Internet Explorer Security Team posted some news on a feature called Phishing Filter that will be available in Internet Explorer 7. As can be seen from his post at the The Microsoft Internet Explorer Weblog, the software will try to determine if a site is a reported as phishing website by checking a database available on a Microsoft server.
Phishing Filter does not check every URL on the Microsoft server. It only sends those which are not on a known list of OK sites or those that appear suspicious based on heuristics. If an URL is checked on the Microsoft server, first the URL is stripped down to the path to help remove personal information, then the remaining URL is sent over a secure SSL connection. The communication with the Microsoft server is done asynchronously so that there is little to no effect on your browsing experience.